Stoneridge: The Facts, Nothing But the Facts

As we review Stoneridge in advance of the oral argument tomorrow, one of the very interesting things about the case concerns the appropriate set of facts to use in describing the case. Reading the briefs sometimes sounds like the parties are talking about two different fact patterns. What's going on here?

Respondents, in describing the facts, rely almost entirely on the Amended Complaint. It was the Amended Complaint that the trial court used when dismissing the case.  Petitioners, however, relied on the second amended complaint. A copy is contained in the Appendix to the Petitioner's merit brief. The second amended complaint was submitted after the district court dismissed the vendors. The complaint contained additional information that was obtained through discovery (although motions to dismiss, some parties settled and provided discovery).

The trial court denied the motion to file the second amended complaint, noting "that plaintiff's motion pleads additional particularity and merely reiterates in part the allegations of the Complaint, and so fails to meet the cited criteria." Stoneridge Inv. Partners, LLC v. Charter Communs, 2004 U.S. Dist. LEXIS 29679 (ED Mo. Dec. 20, 2004). In other words, even the facts in the second amended complaint were insufficient to show primary liability.

Respondents did not ignore the second amended complaint but they mentioned it in an isolated and understated fashion.  According to their brief:    

• "After dismissal, plaintiff moved for leave to file a Second Amended Complaint (SAC). JA 15a. . . . Plaintiff did more fully allege that the Vendors knew or recklessly disregarded that Charter intended to account for the transactions improperly and to deceive its auditors. The Second Amended Complaint alleged that the Vendors’ reckless disregard may be inferred because it is “common knowledge” that equipment purchases are capitalized and that media companies recognize revenue when advertisements are run (SAC ¶¶ 10, 98-100); because Scientific-Atlanta, at Charter’s request, sent Charter a letter stating incorrectly that the $20 per box price increase was due to increased manufacturing costs (SAC ¶ 102); and because the Vendors changed the date of the price increase agreements from September to August, as Charter separately requested of each. SAC ¶ 110.

An incorrectly stated letter and a change in the date of the price increase.  Almost sounds innocuous.  Here is what the second amended complaint actually said:  

• 100.  The Scientific-Atlanta and Motorola agreed to participate in the scheme, the vendors and Charter set about crafting the necessary documentation to support the fraudulent and fictitious transactions. The parties to the scheme knew that if there was a linkage in the documentation or timing of the price increase and advertising purchase, the accountants would treat the transactions as a wash, and neither side would benefit. In order to deceive the auditors and the public, on August 28, 2000, Pietri e-mailed Tom Nilson telling him that Scientific-Atlanta needed to send Charter a letter notifying Charter of a price increase in the set top boxes. . .
• 102. In furtherance of the scheme, pursuant to Pietri’s e-mail to Tom Nilson, on August 31, 2000, Scientific-Atlanta responded with documentation signed by both Steve Kaufman and Pietri claiming that because of increased costs in manufacturing, Scientific-Atlanta was imposing price increases for digital converter boxes scheduled to be purchased by Charter for the balance of the year. Scientific Atlanta knew that this was a lie. . . .
• 106. In September, 2000, Scientific-Atlanta and Motorola drafted and entered into separate written agreements with Charter for the marketing support payments entitled “Spot Telecasting and Digital Marketing Support Fee Agreements.” The terms of the agreements purported to cover part of Charter’s cost for promotional advertisements for Motorola and Scientific-Atlanta equipment. However, Motorola and Scientific-Atlanta agreed to pay 4-5 times more for their advertising time slots than other parties had paid Charter for advertising time slots during 2000. Scientific Atlanta and Motorola knew that they were being charged excessive rates, since these companies engaged in their own advertising campaigns. These defendants had no incentive to challenge the rates since they knew the transactions were shams, solely constructed to give each side the appearance of greater growth.
• 110. The subsequent indictment of Kalkwarf and Barford further charged that the “although the set-top box price increase contracts were not finalized with either vendor until late September, the contracts were both backdated to late August giving the false appearance that the set-top box price increase agreements were negotiated a month before the advertising contracts which were dated in late September.”

The Solicitor General, which relied on the second amended complaint, summed up the facts this way. 

• "The proposed second amended complaint . . . alleges that Charter instructed Scientific-Atlanta to notify Charter that it was raising the price of set-top boxes that Charter had already agreed to purchase, and further instructed Scientific-Atlanta to cite higher manufacturing costs as the reason for the increase.  Scientific-Atlanta followed Charter’s instructions, even though it knew that the stated reason for the increase was false. The parties later entered into an agreement under which Charter would pay an extra $20 for each set-top box it had already agreed to purchase (totaling $6.73 million in excess payments). The parties simultaneously entered into a separate agreement in which Scientific-Atlanta agreed to purchase $6.73 million in advertising from Charter (at rates four to five times higher than those paid by other advertisers).  J.A. 53a-59a.
• The proposed second amended complaint alleges that respondents knew that Charter intended to use the transactions artificially to inflate its operating cash flow. It also alleges that the backdating of the contracts for the set-top boxes was indicative of “[respondents’] scienter and complicity in efforts to mislead Charter’s auditors.” J.A. 53a, 55a, 58a-60a.
• But for its accounting of the transactions with respondents, Charter would not have met analysts’ projections for its operating cash flow. . .

In other words, Charter instructed Scientific Atlanta to misstate the reason for the increase and that the company complied.  The vendors were asked to backdate the contracts to purchase the boxes and did so and "knew that Charter intended to use the transactions artificially to inflate its operating cash flow".  Finally, the vendors were complicit in efforts to mislead Charter's auditor.   

Sometimes you just can't make this stuff up.  The Petitioners of course have to prove these allegations.  But this is a complaint alleging that vendors engaged in sham transactions for a material amount of money involving false documents (including backdating) that were likely to deceive the outside auditors.  In other words, where ever the invisible line between primary and secondary liability, cases involving material amounts of money and falsified documentation that would mislead auditors are not close questions. 

For Supreme Court Justices wanting to restrict the reach of Section 10(b) and Rule 10b-5, this is a tough case.  The law is against them; so are the facts.  It will take quite the judicial alchemy to affirm the 8th Circuit.